Starting from the traditional clearing model, discuss the necessity and complexity of the business clearing of cryptocurrency institutions

The recent sharp appreciation of multiple cryptocurrencies, led by Bitcoin, has once again attracted a lot of attention from the cryptocurrency-related industries, and more and more institutions have begun to enter the market. Today I want to talk about the most important part of the business of these institutions-liquidation.

For people in the traditional financial market, clearing and settlement is not unfamiliar, but in order to let many friends who are not born in financial background have a concept, to give a simple example, A and B have several transactions with each other, A I bought a commodity from B today, and sold another commodity to B tomorrow. After several transactions have occurred, then A and B will enter the clearing and settlement link. Clearing refers to the calculation of multiple transactions between two people together. In the end, it is clear whether A should pay B or B should pay A. How much money should be paid can be calculated clearly; Settlement is It is the actual transfer of funds. When the transfer of funds is completed, the clearing and settlement will also end, and the rights and obligations between A and B are clarified. The purpose of clearing and settlement is to repay, collect and pay the claims and debts of two or more parties (the actual situation is more multi-party participants). The professional meanings of the terms clearing and settlement are very similar. Generally speaking, clearing is to prepare for settlement. Settlement is usually a process of transferring funds and financial assets after the end of the settlement.

The term “clearing” is widely used in scenarios with multiple dimensions, such as companies, banks, securities, derivatives, etc. However, there are significant differences in the clearing business in different fields, the various systems supporting the clearing are also very different, and the involved parties are also different (including buyers, sellers, custodian banks, etc.). In terms of the above-mentioned dimensional scenarios, banks are cleared around payment instructions, securities are cleared around netting, and derivatives are cleared around positions. Taking derivatives liquidation as an example, the entire liquidation process includes: receiving and confirming transaction information, evaluating counterparty risks, calculating margin, managing collateral, managing funds to be settled and owner (or creditor) rights and interests, and other issues that may affect risk management and Event handling of settlement arrangements, etc.

Traditional financial markets favor the central counterparty clearing model

The traditional financial market has a history of hundreds of years, and various businesses have matured. Clearing is in various business lines (such as FOF fund business, securities PB business, seller OTC transaction business, etc.) and various roles (such as buyer, Sellers, custodian banks, etc.) exist, but considering space reasons, the author selects one of the representative “over-the-counter derivatives” liquidation to make an overview.

In the earliest OTC market, a non-standard bilateral clearing model was adopted, and clearing only occurred between the two parties to the transaction. The non-standard model is naturally inefficient. Either party to the transaction needs to invest high costs for liquidation. There is always a huge credit risk in bilateral liquidation, especially when there are multiple counterparties, the resulting credit risk will make the entire OTC derivatives market very fragile, and the default of one participant may even bring systemic risks. .

Later, at the end of the 20th century, due to the over-the-counter credit risk crisis that broke out at that time, a “standardized bilateral clearing model with market makers as the core” was born. Standardization of contracts not only improves market efficiency, but also reduces credit risk. The emergence of the market maker system has fundamentally changed the situation where transaction risks are entirely borne by both parties to the transaction, and has become an important driving force for the standardized bilateral clearing model. The vast majority of traders only need to use the market maker as the counterparty, and the market maker then goes to the market to hedge their own risk exposure. The trader transfers the credit risk of OTC derivatives transactions to the market maker. Compared with the earliest non-standardized bilateral clearing model, the efficiency and safety of the entire OTC derivatives trading market have been significantly improved. But if the market maker itself defaults or is very risky, it will also bring a devastating blow to the market.

Therefore, the bankruptcy of Enron in 2001 sounded a wake-up call for the over-the-counter derivatives market. In 2002, the ICE exchange tried a new clearing model for the first time, and this model has continued to today’s over-the-counter financial derivatives market, which is the Central Counterparty (CCP) clearing model. . The essence of this model is that the clearing house acts as the counterparty to provide unified on-exchange clearing for over-the-counter transactions, but the contract itself is still an over-the-counter transaction. The clearing house intervenes in the clearing as the legal counterparty of the market trader to ensure the smooth completion of the transaction. CCP itself does not provide a quotation, but only provides clearing and settlement services. This model has changed the development trajectory of the entire financial OTC derivatives market.

Institutional business in the cryptocurrency market is also inseparable from liquidation

It is mentioned in the article “An article to understand the market structure and asset types of cryptocurrency institutions” that the currency circle has various institutional roles for different businesses and various types of assets. In fact, these institutions are inseparable from liquidation of various assets involved in different businesses. such as:

For the exchange, as a liquidity pool, the most important module is liquidation except matching. Whether Taker obtains liquidity from the exchange or Maker injects liquidity into the exchange, the final liquidation process is completed by the exchange itself. In the traditional market, the exchanges actually take into account the division of labor, and generally separate the clearing business to a professional clearing house for processing. In the currency circle, the exchange is equivalent to assuming the two roles at the same time.

For FoF funds, such as institutions such as Bixin, it can also be extended to various buyer roles. When they invest in various funds and teams, whether it is after the performance accrual or the risk calculation in the event, they are actually liquidation. It’s just that the delay and accuracy requirements are slightly different. In the performance accrual, the clearing system must help buyers and customers to calculate various rights and obligations; in the event of risk control, the clearing system must timely calculate changes in margin, net value, etc., so that the next decision can be made in a timely manner.

For seller institutions, when they sell or provide financial products (such as loan products) to various customers, whether it is the risk management of the product or the final settlement of the product, it is also inseparable from the clearing system. The seller provides a loan. During the loan period, the seller needs to pay attention to issues such as pledge rate and interest. When the loan is over, the seller also needs to transfer the repayment and settlement funds and assets between the two parties.

For over-the-counter derivatives trading institutions, clearing is even more important. Because generally the positions of over-the-counter transactions will be large, if two institutions are worried about the other’s credit risk, then no one can bear the liquidation. At present, there is an institution in the currency circle called Paradigm, which plays two major roles: one is to find counterparties for over-the-counter trading institutions, which can actually be understood as providing OTC liquidity; the other is to solve the problem of liquidation. The big problem is that Paradigm uniformly places the positions of both parties in the transaction on the exchange (currently Deribit and bit.com) for matching and delivery. At the same time, the exchange assists in the clearing work, which greatly improves security. This is actually very close to the central counterparty clearing model of the traditional market.

There are also institutions like custodian banks, wallets, etc., if transactions, financial management and other scenarios are involved, the clearing module will also be involved.

The clearing system involves complex assets, product categories and participants, and requires high stability and accuracy

After we know that the various business lines, roles and scenarios in the current currency circle are inseparable from liquidation, we naturally know that the liquidation system also has some corresponding characteristics:

The first is that there are many asset classes involved. In the currency circle, in the broad sense of “assets”, there are various mainstream currencies & non-mainstream currencies, loans, funds, derivatives, mining machines, Defi assets, etc. The liquidation involved in each type of asset has its own unique content.

Second, even for a single category of assets, complex products will produce complex liquidation procedures. Taking FOF funds as an example, the priority of fund funds, the hierarchical structure of funds, the rules of fund redemption, and the final commission method, will all complicate liquidation.

Then, clearing involves many parties, including exchanges, OTC counterparties and OTC platforms that provide target liquidity, funders provide liquidity of funds, and third-party platforms such as wallets, exchange wealth management platforms and mining pools provide sales. The custodian bank provides financial guarantees, as well as terminal customers, which are all parties involved in the business, and naturally the clearing system needs support.

For example, in the example mentioned above, Paradigm provides OTC liquidity for two institutions and injects liquidity into the Deribit exchange. At the same time, they hand over the liquidation to Deribit. This liquidation involves four roles: trading Both organizations, Paradigm, and Deribit Exchange itself. If you add other spot liquidity providers (Derbit has no spot), as well as end customers, at least six parties are involved, which requires the clearing system to clearly distinguish their rights and obligations.

Finally, the clearing system has high requirements for stability and accuracy. For example, for over-the-counter derivatives institutions, when they manage a large number of their own positions, the clearing system actually calculates the risk value, margin and other parameters in real time for the institution to make decisions and operations. At this time, the clearing system The stability of the system requires higher requirements. When the final position is closed for delivery, the clearing system must calculate the institution’s equity clearly, so it will naturally have a relatively high standard for accuracy.

Institutions that play a clearing role should focus more on the core of the business rather than the system

At present, the institutions that play the role of clearing and settlement in the currency circle are basically the parties that provide the core of the business, such as the operator of the fund, and the seller/service party of various financial products. Of course, as the future market becomes more and more compliant, there will be custodians/clearing institutions to share part of the clearing and settlement responsibilities. However, whether it is the party that provides the core business or the custodian bank/clearing house, what they do from the perspective of liquidation is very similar, and the merger is discussed.

With the above understanding of the characteristics of the clearing system, many institutional friends should be able to realize that it is precisely because of these characteristics that the complexity of the clearing system is very high, so do you need to develop it yourself?

The author believes that if there are already mature system suppliers in the market, a mature procurement plan is better than all self-research.

First, the organization should focus on the most critical part, and the most critical is not the system.

In terms of business attributes, basically only institutions similar to high-frequency quantitative funds (pursuing Alpha) need to build their own systems. Because the core logic for them to gain revenue is to be able to grab market opportunities as quickly as possible, for this reason they even write their strategies on the chip.

But for most organizations, the essence of their business is to pursue better Beta:

Funds (similar to grayscle, etc.)

Through compliance, reputation, risk control capabilities (to ensure the security of the storage of coins), and sales capabilities (to find large institutions interested in BTC), to obtain long-term & steady growth of the business.

Seller (structured products, lending and other financial service providers, etc.)

Such as FBG, Matrixport, Bixin, and some mining pools, all provide similar financial services. These institutions obtain long-term & steady growth in their business through reputation, sales ability, product design ability (a deep understanding of customers’ financial needs), risk control ability (fund security + position risk management ability), etc.

Companies that pursue beta, no matter how good the system is, without sales, credibility, and financial product design capabilities, business development will not be good. Although the system does not determine the upper limit of business development, it is essential. The accuracy, stability, real-time, applicability, etc. of the system are also very important, otherwise, after the organization reaches a certain scale, the business cannot be effectively carried out.

Secondly, independent system suppliers are superior to institutional self-research in breadth and depth. Because the system provider will serve a large number of institutions responsible for clearing, it will cover various assets, processes and participants in breadth; there are a large number of customer feedback in depth, and naturally will have better performance in terms of stability and accuracy .

Furthermore, considering the time cost, product, development, and testing team management costs, and direct R&D costs, a mature solution is definitely better than self-research.

The 1Token system is mature and stable, which can save energy and cost for the organization

The 1Token CAM system provides front-, middle- and back-office software system support for medium and large financial institutions in the global currency circle.

At present, the leading financial institutions in the domestic field, such as Bixin’s FOF fund, Matrixport’s FOF fund, FBGOne’s seller business, and BitLink’s quantitative trading system, are all customers of the CAM system. Clearing modules are included in these product lines.

The CAM system has three coverages:

Cover all major modules, including trading, clearing, risk control, quotation, transfer/wallet, authority module, etc.

Cover all major types of assets in the currency circle, including funds, (structured) derivatives, lending/allocation, Defi assets, computing power/mining machines, etc.;

Covers various institutions, including currency circle buyers, sellers and custodian banks. Specific business lines such as FOF/MOM, PB, structured product sellers, lending platforms, mining pools, institutional miners, manual/quantitative funds, OTC liquidity providers, etc.

In terms of breadth:

The 1Token team has experience in the development of systems such as lending, allocation, and derivatives in the traditional market, and has experience in systems such as quantitative funds, institutional brokers, and institutional miners in the currency circle.

Scivantage (acquired by refinitiv), the company where the 1Token core team previously worked, is a well-known financial system provider in the traditional American market. Its services include Bank of America, Deutsche Bank, vanguard, Scottrade and other well-known seller institutions in the traditional market.

Through the accumulation of nearly 10 years, the 1Token system module covers the front, middle and back offices of various assets, and can quickly support the customization of needs.

In depth:

Among the various modules, the most demanding system stability is the risk control/clearing and transaction execution system. 1Token’s self-use brokerage system and quantitative fund system have carried an average daily trading volume of 1 billion RMB+ for three consecutive years, with the highest peak value reaching 5 billion RMB+, which fully demonstrates the robustness of the system.

Considering that 1Token CAM’s customers are basically medium and large financial institutions and are very concerned about data security, the system supports localized deployment to protect data privacy.